Activity Based Costing (ABC)

Activity-based costing is a method of assigning

indirect costs to products and services.
This involves finding cost of each activity
involved in the production process and
assigning costs to each product based on its
consumption of each activity.

Steps Involved in ABC

Identification of activities involved in the
production process;
Classification of each activity according to the
cost hierarchy (i.e. into unit-level, batch-level,
product level and facility level);
Identification and accumulation of total costs
of each activity;
Identification of the most appropriate cost
driver for each activity

Steps
Calculation of total units of the cost driver
relevant to each activity;
Calculation of the activity rate i.e. the cost of
each activity per unit of its relevant cost
driver;
Application of the cost of each activity to
products based on its activity usage by the
product.

Example
Activity

A(inRs.)

Relevant cost
Driver

C=A/B

Production of
components

2,313,132

Machine Hours

25,000

93

Assembly of
components

1,231,312

Labour Hours

20,000

62

Packaging

213,123

Units

5,000

43

Shipping

231,230

Units

5,000

46

Set up costs

34,243

No. of set ups

240

143

Designing

1,234,233

Designer Hour

1,000

123

Product
testing

24,234

Testing Hour

500

48

Rent

1,234,233

Labour cost

1,645,644

75%

Summary of Total Cost Incurred in a Project

Cost of Direct material

25,000

Cost of purchased components

35,000

Labour Cost

15,600

Activity

Relevant cost driver

Activity usage

Production of
components

Machine hours

320

Assembly of
components

Labour hours

250

Packaging

Units

150

Shipping

Units

150

Set up cost

Number of set ups

15

Designing

Designer hours

70

Testing

Testing Hour

22

Rent

Labour cost

4500

Computation of activity based

manufacturing overhead
Activity

Relevant cost
driver

Activity usage Activity rate Activity costs

Production of
components

Machine hours

320

93

29760

Assembly of
components

Labour hours

250

62

15500

Packaging

Units

150

43

6450

Shipping

Units

150

46

6900

Set up cost

Number of set ups

15

143

2145

Designing

Designer hours

70

123

8610

Testing

Testing Hour

22

48

1056

Rent

Labour cost

4500

75%

11700

Total Manufacturing overhead

82121

Traditional Costing

Activity Based costing

Direct Material
25000
Purchased components 35000
Labour Cost
15600
Mfg. Overhead (predetermined)
@270/labour hour 270250
= 67500
Total
143100
Billed at 25% plus
178875

Direct Material
25000
Purchased components 35000
Labour Cost
15600
Mfg. Overhead
82121
Total
157721
Billed at 25% plus
197150